(rdan here: I will put part of this post under the fold a little later in the day and delete this comment…I thought more would read it intact at first)

by cactus

This is a follow-up to a I wrote the other day, taking into account some very helpful suggestions from many helpful readers in comments. As noted in the earlier post, this material comes from a book I’m writing with a co-author, and which has benefited greatly from comments and suggestions by many people, including (if not especially) the crowd at Angry Bear.

Essentially, the point of this post is to look at tax rates and see how they affected economic growth (which I will measure as the growth in real GDP per capita) and tax receipts (which I will measure as real tax collections per capita).

Before I go on, one more thing… when I mean tax rates, I don’t marginal tax rates. I mean the actual tax rates, the percentage of income we actually pay in taxes. (I.e., income tax collections / total personal income.) I’m going to call that “Actual Personal Tax Rate.”

The Actual Personal Tax Rate is not a figure anyone ever talks about. Instead, people talk about marginal tax rates. There are a many problems with looking at the marginal rates, first among them that nobody pays the marginal rates. There are also many different marginal rates, there are tax avoidance mechanisms and schemes, and there is the little issue that some marginal rates are less likely to be paid than others. (I understand the Warren Buffet Challenge is still out there.)

But the biggest objection is this – why discuss some theoretical tax rate when we can discuss the amount that people actually pay? (Or don’t, for that matter. Remember – tax evaders are people who evade paying taxes, not who evade paying marginal taxes.)

The IRS provides data on total personal income tax paid as a percentage of the total personal income earned by people in the country. In other words, the data tells us the Actual Personal Income Tax Rate we collectively pay, as opposed to whatever it is we think we pay.

(BTW -links to all data, plus a spreadsheet with a copy of the data, will be provided at the bottom of this post. I would encourage readers to look at the data themselves.)

Let’s begin by taking a gander at what the Actual Personal Income Tax Rate looks like. For consistency with the rest of my book, I’ve broken the data up by presidential administrations. (JFK & LBJ are merged into one, as are Nixon & Ford.)

(Graph 1 of 6)

A few takeaways… First, since 1953, the actual personal income tax rate has never, repeat, never been above 11.6%. That’s right, 11.6% – and that rate was reached in the year 2000. Now, perhaps you, like me, know a bunch of people who say they pay half their income in taxes. Even after throwing in state, local, and Social Security taxes, its hard to reach such a figure. I can only imagine that some of those folks have succeeded in hiring the world’s worst tax accountant and aren’t smart enough to realize it, and the rest are simply massively delusional. (No doubt a few of them will provide comments to this post.)

Another takeaway – Democratic administrations tend to raise tax rates. Carter and Clinton produced year after year increases in actual personal income tax rates. The JFK/LBJ years show a big drop – that was 1964, but both before and after the 1964 drop, tax rates went in a single direction. Conversely, Republicans have been (not surprisingly) more the tax cutting types, especially since Nixon took office. (Note one interesting detail: after a few years in office, presidents Nixon, Reagan, and GW all tempered their original enthusiasm for slashing and burning, perhaps after some David Stockman in their midst managed to notice, as we will see later in this post, that tax cuts have very different effects than advertised.)

So how does the pattern we see emerge? For example – consider Bill Clinton. There weren’t any major changes in tax law until he cut the cap gains rate, but even that shows up only as a one time slowdown in the rate of tax increases. Conversely, George Herbert Walker Bush cut taxes, didn’t he? Well, didn’t he? Wasn’t that what the whole “read my lips” criticism was about?

Well, what causes actual tax rates to rise when Democrats are in office is… enforcement. Enforcement means not appointing people to the top tier of the IRS whose most fervent wish is to see tax rates reduced to zero, unlike many of the Grover Norquist and the frighteningly misnamed “Club for Growth” acolytes that show up when a Republican is President.

Now, the rest of this post is simple. I’m going to show four scatterplots:

1. the average actual personal tax rate in each administration versus the annualized growth in real GDP per capita over the length of that administration

2. the average actual personal tax rate in each administration versus the annualized growth (or shrinkage) in real tax collections per capita over the length of that administration

3. the change in the average actual personal tax rate in each administration versus the annualized growth in real GDP per capita over the length of that administration

4. the change in the average actual personal tax rate in each administration versus the annualized change in real tax collections per capita over the length of that administration

A few comments before going on. First, the figures for the change in average actual personal tax rate will be different than in my previous post. That is because in the previous post, I was looking at the annualized change in the actual rate, whereas this time around, I decided that since the tax rate was already in percentage terms, it made more change to simply look at the average yearly change.

That is, last time around, for, say, the Carter administration, I calculated the change in tax rates from the year before he took office (1976: 9.62%) to his last year in office (1980: 10.85%) as [(10.85 / 9.62) ^ (1/4)] -1, or 3.06%. The problem is, a number of people told me they found this to be confusing, so instead, I’m simply taking 10.85, subtracting 9.62, and dividing by 4. However, I am still annualizing the changes in real GDP per capita and real debt per capita, as those figures are in dollars, rather than percentages.

Here’s Scatterplot 1:

(Graph 2 of 6)

What does this graph fail to show? Well, it does not show that administrations with the highest tax rates produce the fastest growth. In fact, offhand it seems to show the exact opposite, even among Republican administrations. For example, the two fastest growing Republican administrations also had the highest actual personal tax rates.

Here’s Scatterplot 2:

(Graph 3 of 6)

If you can look at this and conclude that higher tax rates result in less real tax collections coming in, congratulations – there’s a volunteer job waiting for you in the McCain camp.

Here’s Scatterplot 3:

(Graph 4 of 6)

As we saw in Scatterplot 1, higher average tax rates don’t seem to produce slower growth. Not surprisingly, therefore, raising tax rates doesn’t do it either. Of the four administrations overseeing the fastest growth rates in real GDP per capita, only one (Reagan) cut tax rates. Of the five administrations overseeing the slowest growth rates in real GDP per capita, all five cut tax rates.

Here’s Scatterplot 4:

(Graph 5 of 6)

Here we see the nonexistence, if not the contradiction of the “raising taxes decreases tax receipts” storyline.

Since this post looks at the Republican claims about the effect of taxes on the economy, I should at least take a peak at the most up-to-date state of the art Republican claims, as put forward by the Republican standard bearer, John McCain. McCain tells us he will cut taxes, and that low taxes are the key to growth. He also tells us that Obama is for plenty of new taxes, and that these tax hikes are going to stifle the economy. So below is one more chart – its basically scatterplot 3 repeated, but this time I added in two shaded boxes. The first represents the area that a President Obama will fall into, according to McCain – tax hikes and slow growth. The second represents that a President McCain will fall into, according to McCain – tax cuts and rapid growth. Here’s the graph:

(Graph 6 of 6)

I’m not saying one of those two boxes ain’t gonna happen, but we have yet to see anyone fit into the Obama box, and Reagan is the only President so far in the red quadrant. I can understand McCain believing both boxes make sense – he’s got that rep for being mavericky and all. But what’s up with the Economists for McCain?

A few final points before I wrap this up:

Data for the actual tax rate is here.

Data for real gdp per capita and population is obtained from NIPA Table 7.1

Data for real tax collections comes from OMB Table 1.3.

I’ve also downloaded all the data and links into this Google Spreadsheet.

Many of the objections usually raised by those who don’t like the results have previously been disposed of, and a collection of the assorted disposals can be found here. I apologize for not having any way to access them selectively, at the moment.

Last thing: I know what a pain in the butt it is to upload these graphs into blogger, so I’m very grateful to Dan for putting up with a guest post with six of them!

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by cactus